California‘s cap-and-trade program was adopted in October 2011 in order to give effect to the California Global Warming Solutions Act of 2006 (AB 32) which requires the greenhouse gas (GHG) emissions in California be reduced to 1990 levels by 2020. The relevant provisions took effect on January 1, 2012. The first compliance period under the program begins on January 1, 2013.

California cap-and-trade has relatively “soft” start as the first deadline for surrendering allowances as a discharge of annual compliance obligation is November 1st, 2014, and by this date facilities must surrender allowances worth only 30% of its emissions (from 2013).

The full settlement (“true up”) for the first compliance period (consisting of years 2013 and 2014) is delayed till November 1st, 2015.

So, it appears that covered entities are allowed sufficient time to elaborate on their carbon market strategies, exploit opportunities as well as to manage inherent risks.

General Requirements

Under the California program covered entities are generally required:

- register with California Air Resources Board,

- report and verify GHG emissions annually,

- comply with recordkeeping and market rules, as well as with other program specifities.

Of central importance is that entities are required surrender compliance instruments to match covered emissions at the end of each compliance period, and in the event that a regulated entity is out of compliance with its cap-and-trade obligations, it is required to make-up for non-compliance, by surrendering three allowances or offsets for every one missed, in addition to replacing the original number of allowances missed.

Compliance Periods

Compliance obligation calculated from reported and verified emissions in brief may be outlined as follows:

The program initially covers industrial facilities, electricity generators, electricity importers and suppliers of carbon dioxide. With the start of the second compliance period in 2015, the program will also include suppliers of natural gas, RBOB, distillate fuel oil and liquefied petroleum gas. Only entities that need to balance annual emissions above a threshold of 25 kt CO2 are included automatically. Entities with emissions below this threshold may apply to be included via opt-in provisions.

California Cap-and-Trade Specificity

Experiences gained by market participants for instance in EU ETS are helpful in the California scheme to the limited extent only. The differences between the two schemes are significant and market mechanisms designed in the California program cause the demand and supply interplay in different manner.

Auctions under California programme have a floor price starting at $10 for 2013 allowances (indexed annually by 5% plus the rate of inflation, which is calculated by the Consumer Price Index). Significant distinctions between European and Californian auction model allow for certain comparisons (see Californian v European model for emission allowances auctions – which of them is better suited to the market), however, it should be noted that practical experiences with fully-fledged carbon auctioning in both schemes are currently not impressive (under EU ETS auctioning as a default way of distributing allowances starts in 2013, in the second trading period 2008 – 2012 there were auctioned relatively small amounts of allowances only, and when it comes to first California cap and trade auction, it took place on November 14, 2012 only).

Entities that are required to consign allowances to the auction and covered industrial entities eligible for free allocation of allowances must have an account in the Compliance Instrument Tracking System Service (CITSS) to consign or receive allowances. CITSS represents a market tracking system that supports the implementation of California’s Cap-and-Trade Program and provides accounts for market participants to hold and retire compliance instruments and to participate in transactions of compliance instruments with other account holders.

The CITSS, being a some sort of an EU ETS emission allowances registry, is also the record of ownership of compliance instruments; records information related to accounts; enables and records compliance instrument transfers; facilitates compliance verification; and supports market oversight through the collection of relevant information.

Establishing accounts in the CITSS is a multi-step process that, according to the ARB, can take several weeks to complete. To establish accounts, each entity must complete the following steps:

- two representatives must complete the user registration online data entry in the CITSS,

Each covered entity is limited to satisfying up to 8% of its total compliance obligation, per compliance period, with offset credits. There is, however, no limit on the percentage of offsets that may be used to satisfy the annual 30% surrender requirement.

For comparison, the limit on the use of international units under the Australian scheme is 50%, but it relates to the flexible charge years i.e. as from 1 July 2015, and in earlier years (so-called fixed charge years) the use of international units under the Australian program is forbidden.

Sector-based offsets, in addition to counting towards the usage limit for total offsets, face in the California cap-and-trade additional limitations. They are limited to 2% of a firm’s total compliance obligation in the first compliance period and 4% of a firm’s total compliance obligation in the second and third compliance periods.

There are currently four offset protocols: for ozone depleting substance (ODS), livestock, urban forests, and US forest projects. Under these protocols, no offsets are allowed outside of the US, Canada, and Mexico. Non-sequestration projects are eligible for credits for a period of between 7 and 10 years. Sequestration projects are entitled to longer crediting periods between 10 and 30 years.

Given the diverse structures of the US and EU administrative, legal, energy and financial markets frameworks, the differences in the scheme designs seem to be inevitable.

But the differences in designs unnecessarily must lead to the opinion that the linkage of both schemes would be impossible. On the contrary, the said schemes need not to be identical, in order to be linked.